8/3/2019 ME L-2

1/34

MARKETS AND COMPETITION

The terms supply and demandrefer to the behavior of

people......as they interact

with one another in markets. A market is a group of buyers

and sellers of a particular

good or service.

Buyers determine demand...

Sellers determine supply

8/3/2019 ME L-2

2/34

DEMAND

Quantity Demandedrefers to

the amount (quantity) of a

good that buyers are willingto purchase at alternative

prices for a givenperiod.

Demand means desire backed byadequate purchasing power.

8/3/2019 ME L-2

3/34

Meaning of Demand

Demand in Economics meansEFFECTIVE DEMAND , that is one

which meet with all its 3 crucial

characteristics: Desire to have a good

Willingness to pay for that good

Ability to pay for that good

In absence of any of these 3

characteristics , there is no effectivedemand

8/3/2019 ME L-2

4/34

Factors Influencing IndividualDemand

Products Own Price

Consumer Income

Prices of Related Goods

Tastes and Habits

Consumer Expectations about

the product

Advertisement Effect

8/3/2019 ME L-2

5/34

Factors Influencing MarketDemand1.Price of the product2.Distribution of Income and

Wealth in the Community

3.Communitys common Habits andscales of preferences

4.General standards of Living &Spending Habits of People

5.Number of buyers in the Marketand Growth of Population

6.Age Structure and Sex ratio ofthe Population

8/3/2019 ME L-2

6/34

Factors Influencing MarketDemand

7. Future Expectations

8. Level of taxation and Tax

Structure

9. Inventions and Innovations

10. Fashion trends

11. Climate or Weather Conditions

12. Customs13. Advertisement and Sales

Propaganda

8/3/2019 ME L-2

7/34

Demand Function

A function is that which describes therelationship between a variable and its

determinants.Thus, demand function for a goodrelates to quantities of good which

consumers demand during somespecific period to the factors whichinfluence that demand.

8/3/2019 ME L-2

8/34

Demand Function

A demand function is a causalrelationshipbetween a dependentvariable (i.e., quantity demanded) and

various independent variables (i.e.,factors which are believed to influencequantity demanded

8/3/2019 ME L-2

9/34

Demand Function

To put it mathematically, the demand functionfor a good X can be expressed as follows:

Dx = f (Y, Px, Ps, Pc, T, u)Where

Dx = demand for good xY = consumers incomePx = price of good xPs = prices of substitutes of x

Pc = prices of complements of xT = measure of consumers tastes & pref.u = other determinents

8/3/2019 ME L-2

10/34

The Demand Schedule and

the Demand Curve

The demand schedule is a table

that shows the relationship

between the price of the good

and the quantity demanded. The demand curve is a graph of

the relationship between the

price of a good and the

quantity demanded.

Ceteris Paribus: Other thing

being equal

8/3/2019 ME L-2

11/34

Demand Schedule

060.00

250.00

440.00

630.00

820.00

1010.00

Quantity ofWheat Demanded

Price of Wheat(Rs.)

8/3/2019 ME L-2

12/34

Demand CurvePrice ofWheat (Rs.)

Quantity ofWheat (kg)

2 4 6 8 10 120

60.00

50.00

40.00

30.00

20.00

10.00

8/3/2019 ME L-2

13/34

Market Demand Schedule

Market demand is the sum of

all individual demands at

each possible price. Graphically, individual

demand curves are summed

horizontally to obtain the

market demand curve. Assume the wheat market has

two buyers as follows

8/3/2019 ME L-2

14/34

060.00

1010.00

Quantity

Demanded(kg.)

Customer A

Price of Wheat(Rs.)

Market demand as the Sum of

Individual Demands

+

1

6

Quantity

Demanded(kg.)

Customer B

1

250.00

440.00

630.00

820.00

2

3

4

5

4

7

10

13

16

Market

=

8/3/2019 ME L-2

15/34

Demand Curve

The demand curve shows how the quantityof a good depends upon the price.

According to the law of demand, as the

price of a good falls, the quantity

demanded rises. Therefore, the demand

curve slopes downward. In addition to price, other

determinants of how much consumers

want to buy include income, the prices

of complements and substitutes,

tastes, expectations, and the number

of buyers.

If one of these factors changes, the

demand curve shifts.

8/3/2019 ME L-2

16/34

Demand Curve

8/3/2019 ME L-2

17/34

Explanation:

A, B and C are points on the demand curve.

Each point on the curve reflects a directcorrelationbetween quantity demanded (Q) and price

(P).

So, at point A, the quantity demanded will beQ1 and the price will be P1, and so on.

The demand relationship curve illustrates the

negative relationship between price andquantity demanded.

The higher the price of a good the lower thequantity demanded (A), and the lower theprice, the more the good will be indemand (C).

8/3/2019 ME L-2

18/34

Price

Quantity

D3

D1D2

Decrease

in

demand

Increas

e in

demand

Shifts in the Demand Curve

8/3/2019 ME L-2

19/34

Law of Demand

The law of demandstates that,

other things equal (ceteris

paribus), the quantity demanded

of a good falls when the price

of the good rises.

8/3/2019 ME L-2

20/34

The Law of Demandis simply the statement that

as the price of a good decreases (increases), more(less) of it will be purchased.

That is, the demand curve is downward sloping.There are two factors that explain this relationship:

1. As the price of a good increases, consumers willsubstitute into other goods (substitution effect);

2. As the price of a good increases, consumers willhave less real income to purchase all goods

(income effect).

The Law of Demand

8/3/2019 ME L-2

21/34

The Law of Demand

The law of demand states that, if all other factorsremain equal, the higher the price of a good, theless people will demand that good.

In other words, the higher the price, the lower the

quantity demanded.

The amount of a good that buyers purchase at ahigher price is less because as the price of agood goes up, so does the opportunity cost ofbuying that good.

As a result, people will naturally avoid buying aproduct. The chart below shows that the curve isa downward slope.

Chi f h t i ti f th L f

8/3/2019 ME L-2

22/34

Chief characteristics of the Law ofdemandare as follows:

Inverse Relationship

Price, an independent variable, & Demand,a dependent variable

Other things remain the same

Reasons underlying the Law of demand- 2reasons are there Income effect

Substitution effect

8/3/2019 ME L-2

23/34

Assumptions of the Law

The Law of Demand in order toestablish the Price-Demandrelationship makes a number ofassumptions as follows:

No change in consumers income

No change in consumers preferences

No change in fashion

No change in Prices of related goods

No expectations of future PriceChanges or Shortages

8/3/2019 ME L-2

24/34

Assumptions of the Law

No changes in size, age composition andsex ratio of the population

No change in range of goods available to theconsumers

No change in the distribution of income andwealth of the community No change in government policy No change in Weather conditions

In short the Law of demand presumes that,except the price of the product, all otherdeterminants of its demand are unchanged

8/3/2019 ME L-2

25/34

Exceptions to the law of Demand

Giffen Goods (inferior goods)introduced by Robert Giffen. Whenthe price falls, people change

preference for want of quality Articles of snob appeal

when the price rises, demand alsorises.

Speculation

Consumer psychological bias/ illusion

people dont buy at clearance sales.

8/3/2019 ME L-2

26/34

Elasticity of Demand

Elasticity is a general measurementconcept . It is a measure of thesensitiveness of one variable to changes insome other variable. It is expressed in

terms of percentage, and is devoid of anyunit of measurement. Demand elasticitiesrefer to the elasticities of demand for agood with respect to the determinants of itsdemand. There is one demand elasticitywith respect to each demand determinant.Thus there are as many demand elaticities

as the number of determinants. The

8/3/2019 ME L-2

27/34

Types of Elasticities

Price elasticity of Demand

Income elasticity of

DemandCross elasticity of Demand

Promotional Elasticity ofDemand

8/3/2019 ME L-2

28/34

Price Elasticity of Demand

It is termed as the extent of change ofdemand for a commodity to a givenchange in price, other demand

determinants remaining constant.e= The %change in qty. demanded

The % change in price

Or,e= Net change in Qty demanded / Net change in price

Original Qty. Demanded Original Price

8/3/2019 ME L-2

29/34

Cont

Representing it in Symbolse = del Q / del P

Q P

= del Q x PQ del P

WhereQ= original demand (say Q)P= Original price (say p)Del Q= change in demandDel P = change in price

8/3/2019 ME L-2

30/34

Types of Price elasticity

Perfectly Elastic demand e= Perfectly inelastic demand e= 0

Relatively elastic demand e 1

Relatively inelastic demand e 1

Unitary elastic demand e= 1

8/3/2019 ME L-2

31/34

Measurement of Price Elasticity1. Point Method

del Q

Ep= Q

del P

P

2. Arc Method

Q1-Q2

Ep= Q1+Q2P1-P2

P1+P2

8/3/2019 ME L-2

32/34

Measurement of PriceElasticity Total Revenue or Expenditure method

Price (Rs.) Weeklydemand(units)

TotalRevenue ofthe firm

(Rs.)

Elasticity ofDemand

9 50 450

8 150 1200 Ep 1

7 200 1400

6 300 1800

5 360 1800 Ep = 1

4 450 1800

3 550 1650

2 700 1400 Ep 1

1 900 900

8/3/2019 ME L-2

33/34

Determinants of PriceElasticity Degree of necessity The proportion of Consumers Income

Spent on the commodity

Habits Existence of Substitutes

Number of uses of commodity

Durable goods

Time

Range of prices

8/3/2019 ME L-2

34/34

Significance of Price Elasticty

Pricing under imperfect competition Policy formulation by the govt.

Resource Prices

Terms of trade

Rate of Exchange

Public utilities